COMMENT: Delivering a net zero carbon built environment is perhaps the greatest and most important challenge for the real estate sector. Inconsistency in how NZC performance is defined within real estate – across property types and new build versus existing buildings – means there is still some uncertainty around what needs to be achieved. The sector is coming together to address this, with industry organisations the Better Buildings Partnership, the Building Research Establishment, the Carbon Trust, the Chartered Institution of Building Services Engineers, the Institution of Structural Engineers, LETI, the Royal Institute of British Architects, the Royal Institution of Chartered Surveyors, and the UK Green Building Council recently launching an initiative to develop an agreed Net Zero Carbon Buildings Standard for the UK.
Impacts to pricing and liquidity related to NZC transition risk are becoming more prevalent, but vary significantly by sector and location. NZC audits identify pathways and actions to transition an asset, and the cost required to achieve this. Value analysis of the impact to returns produces varying results based on the magnitude of investment required, the location and condition of the asset, and importantly, the sector it sits within.
This approach of examining cost and value together can illustrate part of the business case for transitioning assets to NZC. Here, we examine NZC value drivers across different real estate sectors.
Offices
The occupier push towards highly sustainable specification is strongest in offices, with tenant requirements for the highest levels of certification and NZC performance on the increase, and even early signs of a preference for retrofitted buildings over new build due to the lower whole-life carbon impacts of existing buildings. In core markets, sustainable specification is now synonymous with prime.
Landlords are positioning to respond to this increased occupier demand, and also to increasing legislation, planning requirements and lender/investor scrutiny on environmental performance. Challenging science-based targets are filtering down to investment decision making, impacting liquidity and pricing.
An undersupply of NZC space relative to tenant requirements should lead to premium rents for the best buildings in the short term. With the rapid expansion of sustainability criteria for investment, “doing nothing” means the value of an asset will likely be impacted by long-term sustainability challenges, increasing the gap between prime and sub-prime assets.
Industrial and logistics
The weight of capital chasing industrial and logistics stock in recent years has made it difficult to decouple green premiums from the general heat in the market. In the big box sector, new developments are coming through with impressive specifications, and large third-party logistics tenants are now requesting highly sustainable buildings with electric vehicle charging. Volatility of energy pricing is focusing investment into solar panels as well as energy efficiency.
In the multi-let industrial sector, the occupier push is weaker, with landlords more focused on meeting upcoming legislation hurdles.
With the investment market slowing slightly in mid-2022, it is likely that sustainable building requirements will become a much bigger focus for investors going forward, with knock-on effects to liquidity and pricing.
Hotels
Hotels have a wide range of energy intensity depending on the level of amenity. Some new developments have achieved or are targeting operational NZC, showing the art of the possible for the sector.
Hotel operators are making increasing commitments and looking at how carbon emissions can be reduced. Studies indicate that hotel customers find sustainability increasingly important, and operators are well versed in adapting to the elasticity of customer demand.
In addition to potential demand factors, hotels are uniquely positioned to capitalise on NZC improvements, given operational savings go directly to the bottom line, immediately benefiting value. For leased assets, the long-dated income means future legislative compliance is of increasing risk.
As a result, inaction could result in a stranded asset with both higher operating costs and lower demand levels – coupled with higher discount rates to reflect the increased risk.
Retail
The challenges for retail shopping centres include engaging with a high number of tenants whose sustainability focus is elsewhere in their carbon-intensive supply chains, and retrofitting highly energy-intensive stock.
Carbon savings can be made through renewable energy installation and “green boxing” units to ensure tenant fit-outs do not negatively impact sustainability ratings.
Although rising energy prices may increase tenant focus on energy efficient buildings with renewable energy, evidence of pricing impacts of sustainability-related factors is rare in this sector. Legislation is likely to be a key factor impacting obsolescence and pricing going forward.
What next?
Whether you are holding an asset or acquiring an asset, sustainability is a constant, and failure to transition to NZC will affect value. By carrying out a value-integrated NZC audit, every nuance and opportunity can be realised to enhance or protect value – and take action to achieve NZC across the built environment.
Emily Chadwick is head of ESG and risk, valuation advisory, at JLL
